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Section 172 companies act 2006

Chapter 1: Introduction and overview

The Companies Act 2006 s.172 is a compromise between a pluralistic stakeholder approach which obliges directors to consider stakeholders by law in making their decisions and a shareholder primacy approach which concentrates on purely market concerns and leaves stakeholders of companies at the mercy of self regulation . The intellectual revolt against scandals and recession in the 1990s led to an adoption of economic theory which simply and bluntly required more from companies than, in the memorable words of Lord Avebury in the House of Commons, a company’s success relying on “its ability to continue damaging the environment, and within a fairly distant time horizon, making large parts of the globe uninhabitable” .

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Corporate theory has long been a neglected topic in the United Kingdom, and the arguments of American theorists have been predominant in the 20th century with the advocacy of contractual theory attacked by Ireland as emblematic of the problems with shareholder primacy: “with its slavish faith in the efficacy of ‘the market’, its yearning completely to privatise the public company and its uncritical commitment to ‘shareholder value’ as the overriding corporate goal, it is difficult to escape the conclusion that contractual theory has ideological qualities which render it ill-suited to sober, open-minded analysis” .

Of all the scandals in the 1990s the one which has, by both example and regulatory responses, seared an indelible mark on company law is the fall of Enron . This financial scandal concentrated minds and the ripples of discontent reached many countries: most notably in the UK and Australia which embarked on ambitious reforms to ensure that such disasters would not happen again despite moral philosophy being central to UK corporate theory . The result of the drive for reforms in the UK was the Companies Act 2006 of which s.172 was the centrepiece and, as many commentators have noted, the most controversial component . S.172 arguably splits the debate between those who advocate shareholder primacy to maximise profits and those who insist that stakeholder primacy must be introduced into company law to reflect the 21st century and a more moralistic business environment. On the former, FE Mitchell has observed that requiring people to devote their working lives in companies to solely maximising profits is “unhealthy, demeaning and morally corrupting” while on the latter, Easterbrook and Fischel condemn the inclusion of social and moral factors in business as “unnatural and objectionable ‘social engineering’” . S.172 has been criticised heavily as a mere codification of the common law which existed before and further evidence that shareholder primacy is firmly in the ascendant with any benefits to stakeholders being very modest. Patricia Hewitt best sums up the Government thinking behind s.172:

“What are companies forThe primary goal is to make a profit for their shareholders, certainly. But the days when that was the whole answer are gone [my emphasis]. We all have higher expectations of companies in the modern economy…Good working conditions, good products and services and successful relationships with a wide range of other stakeholders are important assets, crucial to stable, long-term performance and shareholder value…We expect companies to create wealth while respecting the environment and exercising responsibility towards the society and the local communities in which they operate. The reputation and performance of companies which fail to do these things will suffer” .

Enlightened shareholder value (ESV) is the UK government’s unique and innovative model of shareholder primacy. The catalyst for s.172 was the Labour Government of Tony Blair from 1997. As Dignam & Lowry have pointed out, successive Conservative Governments under Margaret Thatcher had shied away from interference in the business sector with the free market model so ruthlessly promoted by Margaret Thatcher allowing business to drive forward for profits: the very definition of shareholder primacy and the contractual theories so prevalent in America in the 20th century . Consequently, as will be examined in depth in the following chapters, a Company Law Review Steering Group (CLRSG) was constituted under the auspices of the Labour Government that laid the path to the 2002 White Paper and then the Companies Act reform bill in 2005. A year later the Companies Act 2006 emerged and on 1st October 2007 s.172 became operational . Tony Blair himself was on the side of stakeholders throughout the 1997 election campaign and it took them no less than a decade to install s.172 as, in the words of Alistair Darling , “the heart” of the new legislation.

This dissertation will ask the key question in light of s.172: is it just an entrenchment of the traditional shareholder primacy perspective or a meaningful step in times of crisis for business towards a new approachThe critical analysis of this dissertation will: cover the background and rationale of the enlightened shareholder approach with a special emphasis on firstly Enron and now the UK banking crisis under the framework of corporate governance, examine the section itself and identify the duties owed underneath it, analyse extensively the numerous problems and flaws with s.172, look at the approach of several other jurisdictions including Australia, Japan and Germany in light of the paucity of case law and then attempt to advocate some recommendations for the future. The Companies Act 2006 is very recent and, as pointed out above, there is accordingly little case law on s.172. In the three and a half years since it became operational however there have been cases which have opened it up to the judicial interpretation and guidance it badly needs though only to a very limited and painfully incremental level . With this in mind case law research has been conducted on every single case which has concerned s.172 in the UK up to 2011, even in an indirect manner under derivative actions and unfair prejudice actions against minority shareholders, and will be dealt with in chapter 2. Cases under the common law have also been examined alongside old 1985 Act for a complete picture. The dissertation concludes by arguing that s.172 is a codification of the common law which existed before and in reality does not offer anything significant by itself which furthermore can be considered with some justification to be both artificial and a token gesture. It is only when taken together with other factors does the enlightened shareholder approach in s.172 gain any currency in the current business climate as Fisher points out:

“However, the legislation must be seen in the context of the wider debate about stakeholder value and corporate governance in England. Successful businesses now recognise the importance of brand reputation and are encouraged to behave responsibly by ethical investors, pressure groups, non-governmental organisations and their customers. They will promote good relationships with suppliers and communities, and may acknowledge employee expertise as among their most valuable commodities. While s.172(1) cannot guarantee directors will consider third party interests, it must be seen as a normative measure which, combined with stakeholder pressure, the prevailing commercial climate and a few enlightened shareholders, will firmly encourage a more inclusive, longer-term view of what will promote success.”

The hypothesis of this dissertation is that s.172 of the Companies Act 2006 and the government’s concept of ESV have reinforced the traditional shareholder primacy model and, taken in isolation, reflect only a token gesture towards a model of stakeholder primacy. It is only when analysed together with other advances, such as corporate social responsibility, that s.172 takes on any significance. “Enlightened shareholder value” is a pale imitation of stakeholder value as exemplified in Germany and Japan. Freeman (1984) contributed immensely to this field by first expressing the modern concept which has gained much currency in the last two decades being, in the words of Miles & Friedman, “the pivotal contribution to stakeholder literature” . His words echo Patricia Hewitt’s to a certain extent in trying to emphasise that the days of businesses solely pursuing profit are over and are remarkably prescient for 2011:

“Gone are the ‘good old days’ of worrying only about taking products and services to market, and gone is the usefulness of management theories which concentrate on efficiency and effectiveness within this product-market framework”.

For the purposes of this study the definition of stakeholders adopted is that advocated by Miles & Friedman: shareholders, customers, suppliers and distributors, employees and local communities .

Chapter 1: Background and overview

A. The fall of Enron and theories of corporate governance

The fall of Enron was the catalyst for an international shake-up of corporate governance which had traditionally, at least for the Anglo-Saxon world, been founded upon the contractual theories of American thinkers for generations and filtered into the 2006 Companies Act . Despite the predominance of American thinkers in the 20th century the intellectual tide in the UK was turned by the seminal work of Parkinson in the early 1990’s who first postulated a form of corporate social responsibility and rejected the American contractarian model in the United Kingdom . Parkinson himself distinguished the illustrious author E.Merrick Dodd who, in the shadows of the Great Depression in 1932, argued powerfully that the essence of a company is not a “legal fiction” but in fact reality and that with such power comes the responsibility to perform a social service . For Parkinson however, social responsibility defined by democracy is a precondition to having power. Both Parkinson and Dodd were united, however, in seeing the corporation as a quasi-public company . The idea of corporate social responsibility (CSR), which has become a buzz-word in the modern business world , has prompted many changes in companies which is, in the words of Sheikh, “inextricably linked” to enlightened shareholder value . Voluntary and non-binding codes, principles and initiatives are proliferating at an astonishing speed and indeed a new industry has been born . A glance at many companies’ websites in 2011 reveals that corporate social responsibility is becoming universal although there are those who would deride it as a mere illusion which preserves the status quo in much the same vein as those who attack s.172 and the legal duty of ESV . The Enron fiasco was analysed extensively as a failure of the company to protect shareholder interests, but in reality the repercussions for the stakeholders were equally grave as Clarke observes:

In another sense if Enron had continued to succeed making ever-rising profits by amoral means, exploiting business strategies that wreaked havoc in the economies they operated in, then shareholders interests may have been served, with the denial of every other conceivable economic interest as the company continued to hike prices by exercising monopoly power, destabilising essential energy and other services, creating volatility in markets that undermined the prospects of continuing normal business in other industries, and damaging people’s lives as a result. Little attention has been paid in the literature so far to the stakeholder dimensions of the Enron saga. Enron not only betrayed its shareholders, in a more immediate and direct way it betrayed its customers, and in the end, its employees also.”

Among the many failings of Enron the flaws which are most closely linked to the concerns of stakeholders are firstly the lack of disclosing to the market very significant accounting transactions, secondly failing to inform “market regulators, investors, creditors and others” of the company’s financial position, thirdly failure by the Chairman, CEO and Board of Directors to ensure the correct checks and balances were in place and finally what Clarke describes as: “Fundamental failure in the morality and ethical basis of the decision-making of the company, with systemic deception of investors, manipulation of markets and exploitation of customers” . Enron’s demise came with the filing of bankruptcy on 2nd December 2001. Just a week beforehand $55 million dollars were paid out in bonuses as directors filled their pockets before the Titanic sunk. Scandalously, four thousand employees were laid off just after the company filed for bankruptcy and eventually a chartered accounting firm, Andersen’s, collapsed as well bringing down with it 85,000 employees worldwide .

This fall of an American giant became emblematic of the shareholder primacy model of business which had flourished and, in the eloquent words of Deakin, now holds a place in history: “…the fate of Enron is less important than the future of the business model that it came to represent. Unless the regulatory framework is adjusted to make this model unattractive, it will only be a matter of time before the same approach is tried again.” The consequences for stakeholders were immense and have in part contributed to an ideological turning of the tide in the birthplace of “shareholder capitalism” . The legal result of this was the passing in America of the US Sarbanes Oxley Act of 2002 (SO Act 2002) which introduced a new legal framework into American company law designed to confront the epidemic of corporate scandals in the 1990s, chief of which was the Enron disaster . This regulatory response is important to this study as many UK companies are listed on the US stock exchange and consequently come under the jurisdiction of US law. Furthermore, UK subsidiaries of both American and British companies with upwards of 300 US shareholders are also under the scope of the Act. The details of this Act and the reforms in America will be detailed in chapter 3 which examines the approach in other jurisdictions.

As Deakin points out, however, the important lessons to be learned for the UK were the regulatory ones: Could Enron happen in the UKDignam & Lowry, writing in 2009, point out that there have been no collapses in UK listed companies since Enron . However, with respect to the writers, they were writing before the banking crisis rocked the United Kingdom and the spectre of reforming corporate governance again surfaced with Banks culpable of neglecting both shareholders and stakeholders and images of desperate customers withdrawing their savings from Northern Rock. The run on Northern Rock happened on September 2007, barely a month after s.172 came into effect . The writers also neglect to consider bail-outs: Enron was not bailed out by the US Government by choice whereas Northern Rock was rescued while on the brink with no potential suitors: this suggests that if the test is whether a company fails ie goes into receivership or liquidation then in the banking sector at least regulatory reform would be confused . The Government has published, under the House of Commons Treasury Committee , a report which delves deeply into the causes of the banking failure and, after listing the director’s duties under the 2006 Act with prominence given to s.172, detailed the apologies of the giants of the industry which included Sir Fred Goodwin and Sir Tom Mackillop. It was, however, Andy Hornby’s (formerly of HBOS) apology which best encapsulated the failure of banks operating briefly under the ‘enlightened shareholder value’ regime to properly discharge their duties under s.172 to both shareholders and stakeholders:

“I am very sorry about what has happened at HBOS; it has affected shareholders,
many of whom are colleagues; it has affected the communities in which we live and serve; it has clearly affected taxpayers; and we are extremely sorry for the turn of events that has brought it about”.

As will be argued in subsequent chapters, the fact that the banking crisis flourished under the auspices of s.172 is an extremely worrying development although it must be pointed out that s.172 only became operational in October 2007 . Similar concerns have been voiced about the efficacy of the Starbanes-Oxley reforms, lending credence to the arguments expounded above, which have been articulated by the Wall Street Journal. They persuasively argue that the reforms have led neither to less financial scandals nor less fairness but have instead stifled business growth .

The ripples of the largest bankruptcy in US history lapped against UK shores and the CLRSG’s proposals were drifting into redundancy until the Enron collapse refocused minds, triggering the White Paper and the promotion of the concept of ESV in company law. Enron’s significance is two-fold: as a catalyst for our own company law reforms and ESV as well as providing a bleak reminder to this very day of the dangers of leaving company law uncodified and a style of corporate governance which encourages speculation and reckless lending. The surreal truth is that without Enron there would be no s.172 and in all likelihood shareholder primacy would still be undiluted. Whether that would have made any difference at all to UK company law is debatable as is epitomised by this observation on entrenching shareholder primacy:

“The true lesson of Enron is that until the power of shareholder value norm is broken, effective reform of corporate governance will be on hold.”

B. S.172’s beginnings: the CLRSG and the White Paper

Tony Blair came to power in 1997 with a firm vision of enhancing protection for stakeholders. The impacts of UK scandals in the 1980s and 1990s, including the collapse of the Robert Maxwell Group, lead to three industry committees in the 1990s which shaped opinion and set the agenda for reform. The Cadbury Committee, set up in 1992, looked at boardroom accountability issues, disclosure regimes and the functions of non-executive directors (NED’s) . The proposals of keeping the board as the key decision maker, splitting permanently the roles of managing director and chairman of the board and introducing a requirement to have NED’s on the main board in sufficient number were put into practice by the London Stock Exchange . Next was the Greenbury Committee, established in 1995, triggered by public outrage over the conflict of interest inherent in directors’ setting their own salary limits. Their proposals included requiring that remuneration committees should proceed without any executives as well as imposing onerous disclosure requirements. Dignam & Lowry, however, point out that these reforms were largely unsuccessful as many executives could now simply point to rival companies’ levels of pay and start their salary negotiations at this point . The final committee, the Hampel Committee, arose out of the Cadbury committee recommendations in 1998 and came at a time when New Labour was just one year in government. The main recommendations of this committee were that all of the previous committees mentioned above should be incorporated into one main code . Hampel considered giving institutional investors votes at AGM’s and proposed even more stringent disclosure requirements on remuneration. Most pertinent to this study are their conclusions on the role of stakeholders:

“They considered that stakeholders were best served by the board pursuing profit maximising policies and that a permanent committee on corporate governance was unnecessary. In all the report was more active in rejecting ideas than it was at recommending positive improvements. The London Stock Exchange implemented its recommendations and now the recommendations of Cadbury, Greenbury, Hampel and Turnbull form parts of the Combined Code.”

The Combined Code has survived both the White Paper in 2002 and the 2006 Act untouched and is a self-regulatory mechanism. When the Labour government included corporate governance in their major review of company law, dissatisfaction with the limited recommendations of the Hampel committee inspired them to bring “focus within corporate governance reform on the moral claims of stakeholders to inclusion in the corporate decision-making process” . The Labour government then proceeded to establish the CLRSG to look more deeply into corporate governance. But when Stephen Byers took over from Margaret Beckett as the responsible minister the moral claims of stakeholders were limited to the concept of ESV and remained in place until the final report. As noted above, the recommendations from the CLRSG were drifting in limbo until the Enron disaster put corporate governance again on top of the agenda and instigated the Companies Act 2006.

C. The White Paper of 2002

The White Paper on Modernising Company Law was published in two volumes and broadly adopted the CLRSG’s final recommendations. They produced a very comprehensive review of company law, concluding that the duties of directors were outmoded and misunderstood; being as they were derived from such diverse sources as precedent, EC law and statute often designed to plug the hole in emergency situations. The Trade and Industry Committee remarked: “The result is a complicated and confusing agglomeration of law with no overall coherence or consistency, which is little understood by those who are required to act in accordance with it, and which, it is feared, has become a source of competitive disadvantage.” Against this background they tackled the issue of corporate governance and heard extensive evidence on two polar positions: the ‘Enlightened Shareholder Value’ and the ‘pluralist’ position. The Committee observed in relation to the former:

“The ESV approach towards defining directors’ duties maintained that the primary duty of a company director was to maximise value for the company’s shareholders. However, it added that other relationships were significant in this and therefore needed to be taken into account when judging how to carry out this duty. The interests of employees, customers, suppliers, and local residents, as well as the environmental impact of the company’s activities and its good standing in the eyes of the public, all had to be considered when judging what was in the interests of shareholders. Such an approach would require no fundamental change to existing company law, which obliges directors to act in the interests of members of the company; and therefore any revision of the law along ESV lines would consist of codification rather than significant reform.”

The approach of the Committee echoed the recommendations of the CLRSG in this area by rejecting the pluralist argument completely . The Committee notes on p.8 that the pluralist position would involve a more radical change in company law and would force director’s to take into account the stakeholders of the company and afford no primacy to shareholders. The rejection of this approach is swift and the reasons given are predictably based on the efficiency of the business being paramount: “The Review Group ultimately rejected the pluralist approach, considering that it would confuse the issue of directors’ duties, giving directors little in the way of guidance in decision-making. It also ran the risk of creating a litigious climate for business where those parties who felt they had not been treated as they would have liked by a company’s directors sought recompense through the courts.” The reaction of company lawyers to ‘enlightened shareholder value’ has been a mixture of “apathy” and “disappointment” according to Dignam & Lowry , who observe that although shareholders are unique in being able to ensure compliance with s.172 through derivative actions, many environmental groups and employees hold shares in companies . This factor gives the section more credibility but it has been pointed out that all this depends on an “enlightened judiciary” and the need for interpretation is keenly felt though it is submitted that the scarcity of litigation means that s.172 will unravel incrementally and it could well be 2020 before the section has been fully understood and analysed.

D. The Hypothesis

As noted above, the hypothesis of this dissertation is that s.172 of the Companies Act 2006 and the government’s concept of enlightened shareholder value have both reinforced the traditional model of shareholder primacy and, taken in isolation, reflect only a token gesture towards a model of stakeholder primacy. A look at the case law so far, an examination of the alternatives and the problems, the approach of other jurisdictions and the government thinking behind the White Paper all give credibility to the hypothesis and demonstrate that it is only when taken together with other reforms, such as corporate social responsibility, can enlightened shareholder value move past being but a token gesture. S.172 “raised expectations that it cannot deliver” .

Chapter 2: s.172 and the case law so far

A. S.172 of the Companies Act 2006:

“172Duty to promote the success of the company
(1)A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—
(a)the likely consequences of any decision in the long term,
(b)the interests of the company’s employees,
(c)the need to foster the company’s business relationships with suppliers, customers and others,
(d)the impact of the company’s operations on the community and the environment,
(e)the desirability of the company maintaining a reputation for high standards of business conduct, and
(f)the need to act fairly as between members of the company.”

This section requires directors to take into account stakeholder interests when it is in the interests of the members. Gower & Davies point out that s.172 represents a move from “permission to obligation” with the old common law being exemplified by the case of Hutton v West Cork Railway in permitting directors to take into account stakeholder interests albeit when acting explicitly in the interests of the company. Acting in the interests of members is clearly the overriding duty of s.172(1) but it is in discharging this duty that the directors must have regard to the list of non-exhaustive factors . As Gower & Davies observe, there is no independent value to the stakeholder interests as there would have been under the pluralist approach so firmly rejected by the CLRSG and the test is not a balancing one: shareholder primacy strongly prevails .

The test inherent in this section is a subjective one which imposes, on a director acting in good faith in the interests of the company, a duty which the courts will apply by asking themselves whether it was conclusively proved that the director had not done what he/she had believed to be right. This test is a formulation of the old common law and the interpretation advocated by Lord Greene M.R when he said directors were required to act “bona fide in what they consider – not what a court may consider – is in the interests of the company…” A crucial point emanating from the common law is that the court will not substitute its own view for the board’s judgement . If a director is challenged under this section he/she will have to demonstrate that the interests in s.172 or other interests as case law develops (for example human rights ) informed the decision-making process. This aspect energised a lot of debate in its’ formulation, with many business leaders concerned that huge paper trails would have to be generated to cover the backs of directors trying to discharge their duties under this section although it is submitted that the subjective aspect of the test will mean that “litigation will have only a minor place in its enforcement, just as litigation to enforce the common law duty of loyalty was relatively uncommon and even less successful” and so the threat of mountains of paper-trails is slightly exaggerated. Certainly director’s facing such threats will be concerned to document their decision-making process.

Defining the company’s “success” under s.172 was another concern in its formulation and one which embraces a more general notion of what a company is striving for. Clearly not all companies are purely setup for commercial gain as NGO’s may be purely charitable without explicit financial goals or companies may be formed by leaseholders to hold the freehold of flats . Section 172(2) however brings such companies under the ambit of the 2006 Act:

“Whether or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the relevance to promoting the success of the company for the benefit of its members were to achieving those purposes.”

The thread running through this section is that it is up to the members to define what success is for the company from its articles of association. The requirement to “have regard” to the list of factors set out in subsections 1(a) to (f) is a potentially hazardous one and the government was especially sensitive about claims that the wording of the section would lead to vague “box-ticking” exercises which would undermine the entire rationale of the section:

“The words ‘Have regard to’ mean ‘think about’; they are absolutely not about just ticking boxes. If ‘thinking about’ leads to the conclusion, as we believe it will in many cases, that the proper course is to act positively to achieve the objectives in the clause, that will be what the director’s duty is. In other words ‘have regard to’ means ‘give proper consideration to.”’

Thus in conjunction with the subjective nature of the test, exercised in good faith explicitly in the interests of its members either economic or otherwise, the directors are under a positive duty to take into account the factors referred to above, the discharge of which can only be done by giving proper consideration to them and not simply referring to them in a vague “box ticking” exercise . It should be noted finally that under s.309 of the Companies Act 1985 directors were required to consider the interests of employees and Kershaw notes that an objective element in having regard to the factors and stakeholders in (a) – (f) when “determining what the director thinks will promote the success of the company for the benefits of the members is an objective, not a subjective requirement” . Thus the section cannot be solely analysed as being subjective and it is submitted that s.172 incorporates a subjective test to act in good faith and an objective test to have regard to the various factors and stakeholders in (a) to (f).

B. The interaction between s.172 and derivative actions under s.260 and under s.994 unfair prejudice proceedings

(a) Derivative Actions under s.260

Before reflecting on the case law it is important to discuss both s.260 and s.994 to provide a context for the analysis to follow. Derivative actions under the common law fell within the seminal case of Foss v Harbottle which for many years was the benchmark rule in derivative actions and a member wishing to bring such an action had to bring themselves under the exceptions of the case. The common law exceptions are summarised by Sealy and Worthington as: firstly “the act complained of is ultra vires or illegal”, secondly “the matter is one which could validly be done or sanctioned only by some special majority of members”, thirdly “the personal and individual rights of the claimant as a member have been invaded” or fourthly “what has been done amounts to ‘a fraud on the minority’ and the wrongdoers are themselves in control of the company” . These exceptions were subject to three principles which respectively combined to defeat those who had not been injured personally , where the company could competently resolve the dispute itself and those irregularities which amounted to attempts to ratify or condone the company’s own internal procedures . These principles, combined with the ability to ratify wrongs subsequently as well as the mere possibility vitiating the action, left what Kershaw has aptly described as: “very limited scope to use the derivative action mechanism to enforce breaches of directors’ duties in relation to closely-held companies and virtually no scope whatsoever in listed companies” . The result was a very one-sided action which effectively excluded derivative actions where the law was of the opinion that a decision of the members as a whole could be relied upon given that Foss was concentrating on individual shareholders .

The statutory derivative procedure introduced by s.260 incorporates s.172 and purports to replace the rules in Foss v Harbottle to enable derivative procedures to be brought with greater ease. S.260 (3) provides that “A derivative claim under this chapter may be brought in only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust be a director of the company.” . Significantly for this study under s.261 and s.262 procedures are set out to apply to the court for permission to continue the action as firstly a derivative claim and secondly to continue the derivative claim and s.263 sets out the requirements for permission to be given. Under s.263 (2) (a) permission will be refused outright if the court considers that a “person acting in accordance with section 172…would not seek to continue the claim” and s.263 (3) also makes reference to s.172 by stating that in considering whether permission is to be granted proper attention must be given to the question of the importance a person similarly acting in accordance with s.172 would give to the claim. It is still the case, however, that only members can bring derivative claims and although s.172 is taken into account heavily in this section the various constituencies referred to therein do not, in the words of Kershaw (2009), have a “right to bring a derivative claim” . Kershaw brings attention to one very remarkable point which mitigates this omission: while only members can bring derivative actions there is no threshold shareholder ownership requirement and the logical conclusion of this is that a member with just one share would be sufficient . Concerns of vexatious litigation were dismissed by the government, however, who defeated an amendment to the Companies Bill which would have meant that only those who were members at the time (my emphasis) of the raising of the action would have qualified under s.260 and refused to make such distinction.

(b) Unfair Prejudice actions under s.994

This section, growing out of s.459 of the old Companies Act 1985, provides a remedy for minority shareholders faced with unfair actions of controlling shareholders or even without any controlling shareholders . The section is on the face of matters very wide and it provides that a member of the company may apply by petition for an order where the member feels that the company’s affairs are being conducted “in a manner which is unfairly prejudicial to the interests of members generally or of some part of its members”. The expansiveness of the section is born out in the analysis of the “conduct of the company’s affairs” which can include any “action taken by or on behalf of the company, by the board, the general meeting or any person with delegated authority” and the courts have clearly taken a broad view of conduct for the purposes of s.994. Significantly this section protects the legitimate expectations of a member and contains a similar statutory extension of right to non-members to whom shares have been transferred or transmitted . S.172 is not, unlike the derivative actions, explicitly taken into account but when considering the good faith element in s.994 the courts have taken into account the factors prevalent in s.172 .

C. Case Law

The case law is very shallow even three and a half years after the inception of s.172 and bears out the widely held views that it is not a part of the Companies Act which the government wants to advance by litigation . Most cases interpreting s.172 so far have proceeded as derivative actions raised by shareholders or employees who are shareholders under s.261 where regard must be had to a director acting under s.172 , or actions under s.994 which similarly makes reference to director’s duties while in one instance there has been a judicial review in what is the paradigm example of the case law so far . There has also been one case which has made out a breach of the duty in s.172 .

(a) Judicial Review: People and Planet

The most significant case so far on s.172 has been R (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 (Admin) (QBD). This case was an application for judicial review advanced by the organisation People & Planet regarding the policy adopted by HM Treasury for RBS: the bank which the Government has an 84% stake in after intervening during the banking crisis of recent years. Stephen Copp has voiced his surprise that this did not begin as a derivative claim although perhaps this is not so surprising given the exclusive nature of derivative claims: only if People & Planet were a shareholder in RBS could they have brought an action under s.260 as pointed out earlier . The activists objected to the government’s policy for RBS on two grounds relevant to s.172 as described by Copp:

“First, it had a legitimate expectation that when government exercised its powers, it would do so with a view to preventing public money being spent on projects with the most obviously detrimental impact on climate change. Secondly, the policy was not adopted after proper consideration by HM Treasury in accordance with the Green Book. This was the most substantial ground, including three sub-grounds, namely that HM Treasury had failed properly to evaluate the arguments for a more interventionist policy, that it had regard to an irrelevant consideration, specifically the desirability of industry-wide regulation as opposed to a policy focused on just two banks, and that there was a misdirection of law by HM Treasury as to the effect of Companies Act 2006 s.172.”

The government policy crystallised in the Green Book which assessed all of the options open to the government (including, inter alia, environmental concerns) and came to the conclusion, justifiably in the court’s view, that a commercial approach was the best way forward for UKFI and that should such matters as human rights and environmental concerns drive policy then that would, in the words of the Green Book, “cut across the fundamental legal duty of boards to manage their companies in the interests of all their shareholders” . This is an assertion of the primacy of shareholders debate which has clearly survived the financial crisis intact. Ultimately, Mr Justice Sales rejected the application for judicial review and found in favour of the Government. He based his judgement on the fact that the Green Book demonstrated that the Treasury had “had regard to” both environmental and human rights considerations. He echoed the words of the Green Book quoted above in preserving the overriding legal duty and concluded that management decisions, including policy and acting in accordance with s.172, were decisions best left the directors of RBS and not the UKFI who could at best influence the board of RBS and no more. The risk of minority shareholder litigation, under the auspices of s.994, weighed heavily on the court’s judgement:

“If the board of RBS were to be required to follow a policy whereby its commercial lending did not support ventures or businesses which might be said to be harmful to the environment by reason of their carbon emissions or insufficiently respectful of human rights, then this might presumably have involved sacrificing profits. It is hard to see how this would have been fair to other shareholders who had not invested in the company on this basis” .

Copp goes on to point out that a s.994 action by an oppressed minority of the shareholders would be disastrous owing to the fact that the remedy would be for UKFI or RBS to buy the remaining shareholders out which would have led to an even higher stake for the Government or control swinging back to RBS . This case is notable for exposing some flaws in s.172 such as the difficult weighting to be given to the various factors and the fact that the court implicitly imposed subjective requirements on the section despite some commentators and conflicting case law observing that there are objective elements to the test when having regard to the various factors . The flaws will be analysed more closely in the next chapter.

(b) Derivative actions under s.260 and actions of unfair prejudice under s.994

The new statutory derivative procedure incorporates s.172 by requiring a court to take into account the section when admitting or denying an application for permission to continue a claim and significantly, if the court considers that no director acting in accordance with s.172 would advance such a claim then permission will be refused . As pointed out earlier this new procedure, which requires the submission of evidence in a hearing, was designed to prevent US-style floods of litigants and operates in two stages. The first stage is a written application and the court has to consider whether there is a prima facie case made out: “…a credible case; a substantive claim; a genuine triable issue; or that his case is worthy of being heard in full” .https://login.westlaw.co.uk/maf/wluk/app/document?src=doc&linktype=ref&&context=10&crumb-action=replace&docguid=I9779FB3038A411DF9DBBF195CA62A970 – target-24 The second stage is where evidence will be submitted by the company to demonstrate why the claim should not proceed .

The case law has been fairly active in this field but the results are admittedly mixed. As of 2010, Keay & Loughrey felt confident enough to observe that: “The approach of the courts in these early decisions, generally speaking, seems to lend support to Dr Arad Reisberg’s view that the traditional suspicion of the English courts towards derivative actions will continue especially now that they are “‘armed’ with a very restrictive legislation to ‘justify’ their attitudes” . In light of the two-stage test and the possibility of the action being ratified in accordance with Foss v Harbottle their views seem entirely justified. Since their article has been written however, there have been two important cases which have mitigated their concerns to a small extent and will be discussed below . At common law the equivalent of s.263 (2)(a) was articulated in the case of Airey v Cordell which provided that the test was whether an independent board would sanction proceedings. The court in Iesini and Franbar along with the Scottish appeal case of Wishart held that permission would be refused under s.263 (2)(a) only where no director would advance such a claim and it has been observed that this part of the derivative action will rarely be a bar to such a claim although it should be noted that the court in Iesini held that no director would have supported such a claim in light of its inherent weakness. The court in Iesini also pointed to the factors to be taken into account when considering a s.172 claim under s.263(3)(b):

“the size of the claim; the strength of the claim; the cost of the proceedings; the company’s ability to fund the proceedings; the ability of the potential defendants to satisfy a judgment; the impact on the company if it lost the claim and had to pay its own costs and the defendant’s as well; any disruption to the company’s activities while the claim was pursued; whether the prosecution of the claim would damage the company in other ways (e.g. by losing the services of a valuable employee or alienating a key supplier or customer) and so on. The weighing of all these considerations was essentially a commercial decision, which the court was ill-equipped to take, except in a clear case.”

These factors are not exhaustive and Keay & Loughrey observe that the Scottish appeal case of Wishart added some more: “the amount at stake; and the prospects of getting a satisfactory result without litigation” . The factors under s.263(3)(b) represent a much higher hurdle to negotiate than under s.263(2)(a) and it has been argued that they represent an unnecessary restraint. The court in Iesini was crucially unwilling to substitute its own opinion as to whether a director would continue a claim. For Keay & Loughry this is a major problem and one which could even imperil individual claims of breach under s.172 as well: “If judges do apply the approach suggested in Iesini, namely refusing to make a judgment in relation to commercial decisions made by directors, the derivative proceedings regime, and s.172 itself, might become virtually redundant.” There have been two recent cases in England however, and both were granted permission to proceed . In Kiani permission to continue a derivative action was granted where the director had absolutely no defence to a strongly made out case. On the s.172 part the court held that a director acting in accordance with the section would continue the claim on the basis that there was strong evidence in favour of the applicant and nothing by way of rebuttal from the director. The court also emphasised the fact that should the action be successful then all creditors could be paid and thus this was another f actor which the court took into account . In Stainer, the court also applied Iesini in holding that where substantial interest-free loans had been made out to a company owned by one of the directors the minority shareholders had permission to continue the derivative claim. Similarly to Kiani, Stainer involved an apparently grave breach of fiduciary duty which the director had failed to explain adequately. Roth J observed on the s.172 question:

“In particular, under s.263(3)(b) , as regards the hypothetical director acting in accordance with the s.172 duty, if the case seems very strong, it may be appropriate to continue it even if the likely level of recovery is not so large, since such a claim stands a good chance of provoking an early settlement or may indeed qualify for summary judgment. On the other hand, it may be in the interests of the company to continue even a less strong case if the amount of potential recovery is very large.”

Both of these newer cases involve grave breaches of fiduciary duty and it was obvious that a director in those circumstances would seek to continue the claim in the interests of creditors being paid. Unless these cases are ultimately part of a new permissive approach to derivative actions there is no reason to disturb the observations of Reisberg and Keay and Loughry in asserting that derivative claims using s.172 are unnecessarily restrictive in England . As has been pointed out above, s.994 actions can also include s.172 and there is one recent case which opened up some discussion on the duty to promote the success of the company for the members as a whole .

In Phoenix, the petitioner sought an order under the Companies Act 2006 s.994 that his shares in a company be bought by the respondent (W) at a fair value. W and S were the only shareholders and executive directors of a company (P). While P was being investigated by the Office of Fair Trading, the petitioner warned a potential customer of the investigation and was promptly suspended and later made redundant. In s.994 proceedings the court held granted the petition after assessing S’s good faith in light of the duties imposed by s.172 and concluded that a balancing exercise should be struck in this case between not wanting a contract to be procured by unlawful means against the company losing the contract altogether. The court stressed that this “was one for a director’s subjective judgment, exercised in good faith”. The court further observed that S could not be criticised for not wanting a tainted contract even at the expense of money for the company which is in keeping with the definition of “success” in s.172: not simply the pursuit of profits at the expense of everything else in the company’s vision.

Chapter 3: Problems inherent in S.172

A. The weighting of the factors (a) to (f)

As has been pointed out in Chapter 2, the list of factors for the Director to “have regard to” are non-exhaustive. It was implicit in the one application for judicial review under s.172 that human rights are a factor which would merit consideration under the Act . This has led to some strong criticism from Stephen F. Copp who argues forcefully that the inclusion of human rights on an equal par with environmental concerns in the People & Planet case undermines all of the factors under s.172 which Directors are required to have regard to:

“While “the environment” is explicitly recognised in s.172(1)(d), human rights are not, though such obligations might be read into the requirement to have regard to the impact of the company’s operations on “the community”, also mentioned in s.172(1)(d), or “the desirability of the company maintaining a reputation for high standards of business conduct” within s.172(1)(e). But by placing the two obligations on a par with each other it demonstrates the lack of any real significance to inclusion on the list in s.172. The weighting of these factors appears assumed to have been a subjective matter for the directors, given the reference to management decisions being a matter for the directors’ judgment, and therefore would be difficult to challenge.”

B. The need for objectivity

The apparent uncertainty amongst commentators over whether there are any objective elements to this seems to be settled in light of this case and the quote above illustrates this. The derivative actions thus far under s.172 would resonate this as would the court in Phoenix which distinctly affirmed the subjective nature of s.172 despite the conflicting opinions of a number of authors : the practical interpretation of this section shows that theory has diverged from the case law. The subjective nature of the test renders director’s decisions under it to be “unassailable” . Given the Ministerial statements in the formulation of s.172 however, it is clear that the Government never intended for director’s decisions in the matter to be subject to greater scrutiny:

“We believe it essential for the weight given to any factor to be a matter for a director’s good faith judgement. Importantly, the decision is not subject to the reasonableness test that appears in other legislation…That is in sharp contrast to, for example, decisions on public law, to which courts often apply such a test”.

C. A right without a remedy?

The major problem with s.172 is that under s.260 (1)(a) only a member of the company is able to raise derivative proceedings and under s.994 (1) a similar mandatory bar to any stakeholders wishing to raise actions exists. As Wesley-Key presciently observes, this is a “right without a remedy” . It further needs to be pointed out that under the old case law section 309 of the Companies Act 1985 also restricted locus standi and was very rarely litigated upon and this can be expected to continue under s.172:

“The new duty to promote the success of the company has not been without its critics in its passage through Parliament. One recognises that the lack of direct enforceability of such duty other than by members of the company may leave a provision rarely litigated upon, similar to the existing statutory duty to employees. Others may say that the duty increases the spectre of personal liability for directors of companies. The more readily declared success for those concerned to promote enhanced corporate social responsibility is the greater potential transparency on such issues afforded by the content of the annual directors’ report. Ultimately, judging the success of this provision, like measuring the success of a company, is likely to depend upon one’s expectations.”

The only chance a stakeholder has to institute a derivative action or an unfair prejudice action is under the opportunity afforded by the fact there is no threshold ownership requirement of shares . But having to acquire shares in a company merely to raise an action against a director acting in breach of s.172 is a somewhat tortured and circular manner to hold directors to account. It is true, however, that some employees are shareholders and may take advantage of this section but bluntly employees who are not shareholders are isolated.

D. Judicial reluctance to make business decisions

The English courts are notoriously averse to interfering with decisions in companies and the concept of ‘enlightened shareholder value’ has not alleviated this problem. As Perry & Gregory observe there is a “liberal view that directors should be motivated to take commercial risks (albeit prudently)”. This problem is institutional and the thinking of the courts is aptly demonstrated in the case of Iesini , a case which has become the most cited among all of the derivative actions arising out of the new statutory procedure under s.260:

“Worryingly, the remarks of his Lordship suggest that judges will defer to the decisions of the directors. The remarks are in the same vein as those of judges of the past who have resolutely refrained from passing judgment on what directors have done, on the basis that directors have to make business decisions and judges are not qualified to second guess them on such matters. While the Law Commission intended the courts to show deference to directors’ commercial decisions, if this approach is applied widely then it is going to be a rare case when permission will be given.”

Every derivative action so far has cited and applied Iesini which lends credibility to the view that the courts are going to be reluctant in holding director’s to account in derivative actions and by analogy actions under s.994.

Chapter 4: The approach in other jurisdictions
A. Germany

Germany is often cited as an example to other countries in the sphere of corporate governance and indeed Japan has heavily modelled its own company law on Germany and in some instances taken it to another level: both are considered exemplary models of stakeholder primacy . In Germany they have adopted a vision of the company which is not solely based on shareholder primacy like in the UK and the USA but have what is called a “co-determination” principle which states that both shareholders and workers should take part in the running of large companies. Germany has a two-tier board structure comprised of a management board (Vorstand) and a supervisory board (Aufsichtsrat). It is within the supervisory board that employees are represented as well other non-managerial persons including outside directors and even union representatives . This is the way that Germany has chosen to enshrine stakeholder interests and it is a radical departure from the UK model even in ‘enlightened’ shareholder form in s.172 of the Companies Act . Schwarz, in considering whether the German model is appropriate to import into Australian corporate governance, points out that the German model, indicative of their social free market economy, is so much more than simply allowing employees in a supervisory capacity which is above the board of executive directors and gives examples of sophisticated consumer protection and the robust protection of creditors of German corporations who are secured by a minimum deposit of 25,000 euros in every entity which has limited liability . There are restrictions to the concept of co-determination, however, as articulated by Schwarz:

“Because of its far-reaching consequences, actual co-determination according to the MitBestG and DrittelbG is limited to companies with at least 500 employees. The full scope of co-determination, i.e. with equal representation on the supervisory board, applies only to companies with at least 2,000 employees. Therefore co-determination concerns mainly large, mostly stock exchange listed companies. Overall, out of the about 3.2 million active German enterprises there are only 729 entities which are subject to co-determination according to the MitBestG.”

A further limitation on the application of co-determination is the type of company involved. The principle is not applicable to partnerships but only to limited liability companies in their various forms. The GmBH (limited company) is the most popular form of company and there are about 500,000 currently registered and operating. Having an extra board to supervise the executive directors is optional if there are less than 500 employees but mandatory if the figure is higher under German company law . A key figure emerges from Schwarz’s analysis: “Currently, only 341 out of the approximately 500,000 active GmbHs are governed by the provisions of the MitBestG, and thus subject to the full scope of co-determination” . The full scope of co-determination referred to by Schwarz is a reference to the two-tiers of co-determination (Drittelbeteiligungsgesetz (DrittelbG) and Mitbestimmungsgesetz (MitBestG)) with the key difference being: “the fact that [for the DrittelbG] the Aufsichtsrat [supervisory board[ must consist of one-third employee representatives who are elected by the employees instead of the shareholders. If the company employs more than 2,000 people, the stricter MitBestG becomes applicable, which, inter alia, means that employees are entitled to occupy 50 per cent of the seats within the supervisory board.”

Including stakeholders on the boards of major companies is nonetheless an inspired way of addressing their problems and one which will be addressed in the recommendations chapter of this study. Cracks have begun to appear in this model, however, with Kiarie noting a backlash in German company law:

“German companies are also shying away from the strong employee position as companies are complaining that the national inclusive measures are burdensome and hindering change. Siemens is an example of a company that has abandoned stakeholder value for a more shareholder-oriented model: the new economic value added management theory. These examples demonstrate the failures of the stakeholder model, thus suggesting that it is not any better.”

Siemens is a very powerful German company and their move toward the shareholder model is a warning sign that stakeholder theory is under great pressures in the 21st century. Siemens is an example of an Aktiengesellschaft: the form of company preferred by very large companies who wish to raise capital on the stock market to run their operations and who, obliged by the law, must have a two-tier board . A move towards shareholder primacy is not surprising and indeed it has been observed that Germany’s strong welfare state and the nature of co-determination has enabled Germany to, in a sense, have the best of both worlds: though for how long this remains viable is uncertain .

B. Japan

A still different model of stakeholder supremacy is enshrined in Japanese company law which, going further than even the German model of co-determination, has a relational board structure which is made up of representatives from all stakeholder groups: employers, creditors and suppliers. Their model has been christened a “coalition of interests” based on consensus and cooperation which balances all groups equally against each other with no one group being pre-eminent. Jackson points out that the Japanese model is the very opposite of the German one with its strong level of legal intervention and two-tier board system whereas Japan has: “…a unitary board of directors with only minimal legal distinctions between inside and outside members or between management and monitoring functions, such as the role of the statutory auditors” The differences between the two are described as being based in Japan’s more community or social model the symbol of which must be Japan’s long tradition of lifelong employment which has endured albeit in a slightly altered form for generations . A good example of the rationale behind the Japanese system can be found from a corporate governance meeting in Tokyo from 2001 and reported in the Financial Times:

“Hiroshi Okuda, chairman of Toyota Motor Corporation and of the Japan Federation
of Employers’ Associations, told the assembled money managers that it would be irresponsible to run Japanese companies primarily in the interests of shareholders.. . .Mr. Okuda made his point by telling guests what Japanese junior high school textbooks say about corporate social responsibility. Under Japanese company law, they explain, shareholders are the owners of the corporation. But if corporations are run exclusively in the interests of shareholders, the business will be driven to pursue short-term profit at the expense of employment and spending on research and development. To be sustainable, children are told, corporations must nurture relationships with stakeholders such as suppliers, employees and the local community. So whatever the legal position, the textbooks declare, the corporation does not belong to its owners.. . . ‘In Japan’s case,’ said Mr. Okuda, ‘it is not enough to serve shareholders.’”

However, just as with the German model described above, there have been significant problems with the Japanese approach, symbolised by their economic woes:

“Japan is consciously moving to import shareholder value as an antidote for its recent economic ailments. Lifelong employment is coming to an end and redundancies are being witnessed. The closure of five Nissan plants and the collapse of Yamaichi securities saw massive redundancies, a phenomenon that was previously unthinkable.”

Japan, like Germany, has learnt to adopt the notion of shareholder primacy to a certain degree while preserving their admirable stakeholder principles. The advent of s.172 of the Companies Act 2006 has, far from imitating Germany or Japan, in fact entrenched the primacy of the shareholder in UK law.

Chapter 5: The future of ‘enlightened shareholder value’

A. The case for a duty of care

Lord Goldsmith, when debating the new Companies Act in Parliament and in particular s.172, rejected the idea of adopting the pluralist approach discussed in chapter 1 of this study .
The White Paper of 2002 heard substantial evidence on the pluralist-ESV debate with the Corporate Social Responsibility Coalition (CORE) arguing powerfully for a duty of care to be adopted: owed by directors to various stakeholders . The White Paper notes:

“Coalition (CORE) supported the introduction of a ‘duty of care’ along the lines of that
encapsulated in existing Health and Safety legislation, where there was not necessarily
direct input from the stakeholders into decisions of company boards but the company, and the directors, remained responsible for the impact of their activities on other stakeholders and were forced to consider them fully” .

The White Paper gave very short shrift to this idea and plainly felt that to accede to such a request would be to undermine the model of shareholder primacy so entrenched in UK and US law. The Health and Safety at work act is also cited by Miles & Friedman as an example of stakeholder protection which involves the development of a risk policy and providing adequate measures to prevent workplace accidents to protect employees . The concept of a duty of care is of course objective and would cut through the problems experienced thus far with the subjective test so far applied in s.172 judicial review proceedings and derivative actions. However, to force directors to take into account stakeholders in such a fashion would irrevocably alter the capitalist model and potentially expose companies to vexatious litigation such as Kershaw foresaw in relation to the government debate on an amendment to the Companies Bill to the effect that a minimum threshold ownership requirement of shares was needed . It should be noted that there are significant criticisms of such an approach and they are summarised by Miles & Friedman as firstly weakening the fiduciary duty owed by managers to stockholders, secondly weakening the power of certain stakeholder groups such as those who do not have a “special relationship” with the management, thirdly weakening the company as a whole by taking into account all stakeholders the company would palpably be at a competitive disadvantage and would lose stockholders and finally such an approach would irrevocably alter the long-term characteristics of the capitalist system . On this last point it has been observed that the “Invisible hand” of the market propounded by Adam Smith disciplines companies and, perhaps more significantly, that if corporations were under such a duty of care then they might become “literally unmanageable” or in the unforgettable words of Steinberg:

“A business that is accountable to all is actually accountable to none”.

B. The case for ‘soft law’: Australia

Australia, like the United Kingdom, undertook a review of corporate governance in the wake of Enron as part of initiatives to address the crisis of corporate governance . The publication of two reports in 2006 on corporate social responsibility saw Australia split from the British position by rejecting the ‘Enlightened Shareholder Value’ approach strongly and arguing for an approach centred on ‘soft law’:

Despite its rhetoric the United Kingdom’s approach to company law reform remains wedded to gradual, piecemeal tradition of its common law roots. Australia, on the other hand, has the opportunity to grasp the nettle of reform of this area of law in order to create a model from which the United Kingdom could learn much, though it may be said that even the Australian approach does not go far enough. It seems that many of the limitations that the two committees viewed as part of the enlightened shareholder value model, particularly the uncertainty surrounding directors’ duties to take various non-shareholder interests into account, are in fact reflected in the “soft law” recommendations for corporate social responsibility in Australia. Consequently, the committees’ findings will make very little difference to how boards make decisions.”

There have been some advocates of the ‘soft law’ approach in the United Kingdom most notably Stephen Copp who argues bluntly that: “Company law is not the appropriate vehicle for the achievement of environmental or human rights objectives beyond what the law requires generally. To use it as such would impose costs on non-consenting shareholders and, in the case of RBS the taxpayer. It is not the business of government to run banks and, if government were to attempt to do so, one suspects it would do so badly” . He was writing in light of the failed attempt at judicial review of the Government’s policy regarding the state-owned RBS but his argument is powerful when considering the point that to compromise shareholders who have invested directly in the company at the expense of stakeholder duties would lead to s.994 unfair prejudice actions and internal strife. He then goes on to call for a “traditional statement of a director’s fiduciary duty of loyalty” and derides s.172 as being a construct which quite simply “raised expectations that it cannot deliver” . A final point to be made is that Miles & Friedman draw attention to the fact that such “indirect stakeholder laws” are “more coercive” and more “effective” .

Chapter 6: Recommendations

A. Lessons from Japan and Germany

Direct stakeholder representation on the board’s of companies would allow UK company law to take into account stakeholder interests at the highest level and avoid the damaging debate of ‘hard’ vs ‘soft’ law. As has been discussed earlier, a duty of care is inadvisable owing to the detrimental effect on shareholders, the capitalist system, fiduciary duties owed by directors and the company as a whole while ‘soft law’ is precisely what the ‘enlightened shareholder value’ under s.172 has been criticised as being in a different guise: a tokenistic approach which directors will only pay lip-service to in order to satisfy. Given the inherent weaknesses of s.172 discussed in chapter 3 it is advisable to step above the debates and introduce a more sophisticated system of stakeholder models as exemplified in Germany and Japan. This study recommends the German approach in light of its adaptability to shareholder primacy although a strengthening of the co-determination principle would be welcome to include more companies and an abolition of the two-tier system with just the mandatory system in place for larger companies. The creation of a supervisory board of stakeholders like in Germany is also a possible route and one which would preserve the executive board. Japan’s model has seen some bitter setbacks and the long term economic woes of the country have undermined its admirable stakeholder philosophy. Fisher observes:

“Stakeholder value does not have to be enforced via a legal formulation of directors’ duties as in s.172(1). It can be facilitated by direct participation and board representation, interests can be addressed at the AGM or protected by non-executive directors or companies can be asked to supply information about their impact on stakeholders so that informed decisions can be made. Germany’s codetermination system lets workforce representatives sit on the supervisory board, while Japan’s relational board structure includes representatives of employees, creditors and suppliers. Australia rejected the English approach, preferring soft law. So the CLRSG could have adopted a stakeholder-friendly approach without embroiling directors in weighing up conflicting needs if this was a primary concern.”
B. Giving the right a remedy and locus standi

This recommendation is quite simple: stakeholders should have locus standi to bring derivative actions against directors in breach of their duties under s.172. Although there is some scope for stakeholders, as ?1 shareholders, to bring themselves under the ambit of s.260 of the 2006 Act stakeholders should have locus standi as a matter of right utilising the definition of stakeholders adopted by this study in the beginning: shareholders, customers, suppliers and distributors, employees and local communities . Bearing in mind the likely outcry that would follow such a proposal there could be controls imposed upon such a procedure to ensure it is not open to vexatious litigants. There could be minimum requirements in each of the fields advocated above. For example, in terms of customers only customers who have spent a certain amount of money in the business may have locus standi or only employees of a certain amount of years would qualify. These safeguards would tilt the balance in favour of a derivative system which actually allows directors to be held to account rather than a system which simply blocks all but the gravest of breaches .

The statutory derivative procedure also requires reform given, for example, that the hearing in Iesini took four days and descended into a mini-trial. The two stage procedures which take into account s.172 are far too restrictive and need to be relaxed or as Copp has observed, the whole process and s.172 risks becoming “redundant”.

C. Introducing an objective test

Although the Government would be stridently opposed to any kind of objective test enshrined in s.172 this is exactly what is required to allow breaches of this duty to be litigated. If s.172 is not litigated then it will survive in its present form for decades without any case law just as the equivalent section under the old Companies Act 1985 did. This author would argue that such a drifting provision without extensive litigation to provide judicial interpretation would render s.172 obsolete and reinforce the notion that “enlightened shareholder value” is but an illusion. A reasonable person test would open up the section to the scrutiny of the courts and move us away from the current situation where a subjective test renders all but the gravest breaches of director’s duties “unassailable” which is both unfortunate and not in keeping even with the modest ambitions of s.172. On a final note in this recommendation the deferential behaviour of the courts towards company directors could also be fought by applying public law principles to company law. Gower & Davies points out that there has been a significant amount of support for applying the “Wednesbury Reasonableness” test to directors in the exercise of their powers. The Government was opposed to this development but since the test is set very high then this author would have no qualms with introducing this element of public law into the private sphere .

D. Guidance on the weighting of factors

This point depends very much on whether the subjective test remains in place; if it does then whatever the guidance on the “factors” there would be no realistic prospect of succeeding under s.172 anyway. Assuming that objective elements creep into s.172 over time (and this is very likely) then guidance on the factors is badly needed. As was pointed out earlier in the case of R (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 (Admin) (QBD) the court introduced, somewhat unexpectedly, human rights as a factor on an equal par with environmental concerns. Although the application was swiftly rejected this judicial development has lent confusion to how the factors are to be weighted against each other and whether inclusion on the list has any significance whatsoever. This author would respectfully submit that the inclusion of human rights is welcome but a publication of guidance on how each of the factors is to be weighed would be a welcome advance.

In conclusion s.172 and ‘enlightened shareholder value’ represents only a codification of the prior common law and does not significantly move UK company law towards stakeholder primacy but rather entrenches the notion of shareholder primacy: a great opportunity has been lost to alter our system and what is left will, in the author’s submission, be a harmful legacy on Company law in the UK with an almost unenforceable section which serves the interests of stakeholders only when taken into account with other notable reforms including non-binding codes such as Corporate Social Responsibility and a painfully slow change in corporate culture. The hypothesis of this dissertation, that s.172 is but a token gesture in isolation which raises expectations it cannot meet, demonstrates that our concept of shareholder primacy has in fact never been stronger. The government was incredibly quick to banish a pluralistic approach without considering board participation of stakeholders in Germany which avoids both the pitfalls of stakeholder and shareholder primacy by placing stakeholders into the decision-making process.

The result of the hasty reforms is a section which is riddled with errors and lacking in the judicial interpretation it badly needs to actually be of utility to stakeholders. In denying locus standi to stakeholders in derivative actions, the absence of any guidance on the factors in (a) to (f) and their respective weight as well as the judicial deference to directors in making commercial decisions and the subjective tests which render directors in an “unassailable” position in good faith, s.172 is in need of being repealed or interpreted. Since the lack of litigation is already obvious it is the submission of this author that the most fundamental change would be to grant locus standi to stakeholders in s.260 derivative actions: this move would rescue s.172 from obscurity in legal textbooks and herald the setting of the sun on the shareholder primacy era. Speculation that s.172 could be used to fight both the bonus culture endemic in UK banks and future oil disasters on a par with the BP deepwater horizon are noble visions but, with respect, betray the reality. Australia rejected such piecemeal reform and they were wise to avoid ‘enlightened shareholder value’: we should follow suit.


Books & Journals:

Adeyeye, Adefolake (2010) ‘The Limitations of Corporate Governance in the CSR Agenda’ in Company Lawyer vol 31(4) pp 114-118

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Allen, Marquez & Carletti Stakeholder Capitalism, Corporate Governance and
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MitBestG §§1, 7.
Companies Act 2006
Companies Act 1985

Case law:

Bamford v Bamford [1970] Ch 212 (Court of Appeal)

Hutton v West Cork Railway (1883) 23 Ch.D at 673

Re Smith v Fawcett [1942] Ch.304 at 306

Regentcrest plc v Cohen [2001] 2 BCLC 319

R (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 (Admin) (QBD)

Foss v Harbottle (1843) 2 Hare 461 (Chancery Division

Phoenix Contracts Ltd Re [2010] EWHC 2375 (Ch) (Ch D)

Mozley v Alston (1847) 1 Ph 790

MacDougall v Gardiner (1875) 1 Ch D 13 (Court of Appeal)

Re Phoneer Ltd [2002] 2 BCLC 241

Re Citybranch Group Ltd v Rackind [2004] 4 All ER 735

Franbar Holdings v Patel [2008] EWHC 1534 (Ch)

Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch)

Kiani v Cooper [2010] EWHC 577 (Ch)

Mission Capital plc v Sinclair [2008] EWHC 1339 (Ch)

Stainer v Lee [2010] EWHC 1539 (Ch) (Ch D)

Stimpson v Southern Landlords Association [2009] EWHC 2072 (Ch)

Wishart, Petitioner [2009] CSIH 65 (IH)

Fanmailuk.com ltd v Cooper [2008] EWHC 2198 (Ch)

Phoenix Contracts Ltd Re [2010] EWHC 2375 (Ch) (Ch D)

R (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 (Admin) (QBD)

Deir v Al Athel [2011] EWHC 354 QB

Southern Counties Fresh Foods Ltd, Re [2008] EWHC 2810 (Ch)

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